A fixed-income chief whose firm oversees $3 billion lays out his plausible scenario for a global markets crash that originates in US Treasuries – and warns China continues to pose a threat

  • Fixed income chief Eric Vanrae, who's also a portfolio manager at a firm overseeing $3 billion, forecasts a global financial markets crash if there is a US Treasury sell-off.
  • Goldman Sachs expects the long-end of the curve to rise to 1.3% by year end 2021, according to a note published last month.
  • China could sell Treasuries as a weapon in the US-China "commercial war," he said 
  • Visit Business Insider's homepage for more stories.

The coronavirus pandemic has caused a huge flight to quality, making traditionally "safe haven" assets like US Treasuries and gold highly sought after.

This, alongside large stimulus packages from the Fed, caused a rapid escalation of US Treasury prices, compressing yields and lowering borrowing costs across the US economy.

However, with expectations of economic recovery in 2021, demand for US Treasuries could decline just as fast as it rose, potentially increasing yields. But, this could present a huge crisis for the global economy, according Eric Vanrae, head of fixed income at Swiss Banque Eric Sturdza SA, and a portfolio manager on both the Eric Sturdza Strategic Bond Opportunities Fund and the Sturdza Family Fund.

"In my opinion, a massive steepening of the curve would lead to a major global financial crisis because equities could collapse, and the economy could collapse, because if long-term yield increased sharply, all of the mortgages will be at risk in the US and consumption will decrease. If you have to pay more for your mortgage, you will not spend and private consumption is still 70% of the [US] GDP," he said.

"Unfortunately, a lot of people focus on the 10-year Treasury, and I think that above 1.10/1.15, the Fed will buy Treasuries. So I think that the maximum correction for 10 years is 1.15 and it would be 1.90/1.95, probably 2% on the 30-year if there is an exaggeration," he added.

Vanrae argues that Treasuries will stay "more or less at the level they are today because a lot of people are afraid of a steepening of the curve," he said, adding that a Treasury sell-off "is not possible because the US is still too fragile."

"If we have a steepening of the curve, it would be too painful for the US economy and for the world. So I think that if one day there is a steepening of the curve the Fed will let the market do [that], but up to a certain point. At a certain point, the Fed will buy Treasuries and will implement a yield curve control in order to stabilize the slope of the curve," he said.

However, there is scope for a small correction, Vanrae said. "I think that there is room for a steepening of the curve, but a very small tightening," he added, saying that the Fed will "want to show to the market that inflation will come back one day."

Vanrae has "dramatically" decreased the weight of US Treasuries in the Strategic Bond Opportunities Fund portfolio, only holding Treasuries maturing in 2021 and 2022, he said. The fund still holds 30-year TIPS, he added, but conceded that he will "start to exit from the TIPS once the 30 year break-even is… between 2-2.10%." 

"TIPS are still attractive because inflation fields and reflation will be a key question at the beginning of the year. So there is still room inflation breakevens to increase a little bit," he said.

Conversely, last month US investment bank Goldman Sachs published a note detailing expectations for an increase in rates at the long end of the curve.

"As the economic recovery consolidates next year, we expect to see more differentiation across the curve, with policymakers committing to keeping front-end rates low, but higher expectations for real growth and inflation driving long-end rates higher," the strategists, including Zach Pandl, wrote.

But for Vanrae, this type of analysis is "too academic a view," arguing that under normal circumstances, he would agree with it. "But, it's a very strange situation. Nobody knows the success of the vaccine, for example, and if there will be a third wave somewhere in Europe or in the US next year. There is still a lot of weaknesses in the US economy, including unemployment," he said.

China also poses a substantial risk, he said, arguing that the aggressive "commercial war against China" has support from both Trump supporters and Democrats, meaning it could continue into Biden's presidency.

"If the Democrats continue the same policy and are still aggressive or perhaps more aggressive, the Chinese could sell Treasuries sometimes – it's a weapon in this commercial war," he said.

Get the latest Goldman Sachs stock price here.

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